Publications:
Quarterly Derivatives Fact Sheet -- First Quarter 1998
Read Section: General.......Risk........Revenue.....High-risk Mortgage Securities and Structured Notes
RISK
Notional amounts are helpful in measuring the level and trends of derivatives activity. However,
these amounts may be a misleading indicator of risk exposure. Data such as fair values and
credit risk exposures are more useful for analyzing point-in-time risk exposure, while data such
as trading revenues and contractual maturities provide more meaningful information on trends in
risk exposure.
Credit exposures are reflected in Table 4. However, Table 4 does not reflect the full effects of
bilateral netting on potential future credit exposures (i.e., the add-on component). Under the
current risk-based capital guidelines, banks have the option of either calculating their netted
potential future credit exposure on a counterparty basis or approximating their netted potential
future credit exposure on an aggregate basis. The method chosen must be used consistently and
is subject to examiner review.
There was an $8 billion decrease in the first quarter in total credit exposure from off-balance
sheet contracts to $348 billion. Relative to risk-based capital, total credit exposures for the top
eight banks decreased to 260 percent of aggregated risk based capital in the first quarter of 1998
from 290 percent in the fourth quarter of 1997. The decrease in the dollar amount of total credit
exposure appears to be largely due to changes in market rates, as well as the overall level of
activity in the first quarter. Credit exposure would have been significantly higher without the
benefit of bilateral netting agreements. The extent of the benefit can be seen by comparing gross
positive fair values from Table 6 to the bilaterally-netted current exposures shown on Table 4.
[See Tables 4 and 6.]
Past due derivative contracts remained at nominal levels. For all banks, the book value of
contracts past due 30 days or more aggregated only $2.3 million, or .0007 percent of total credit
exposure from derivatives contracts. A more complete assessment of the magnitude of troubled
derivative exposures would include non-performing contracts as well as past due contracts. Call
Report instructions, however, currently do not require banks to report totals for non-performing
derivative contracts. Therefore, use of past-due information alone does not provide a complete
picture of the extent of troubled derivative exposures. During the first quarter of 1998 banks
charged off $157 million due to credit losses from off-balance sheet derivatives, or .05 percent of
total credit exposure. For comparison purposes, net loan charge-offs relative to total loans for
the quarter was .16 percent. Banks' relatively small loss figures reflect both the current healthy
economic environment and the generally high credit quality of counterparties and end-users with
whom banks presently engage in derivatives transactions, as well as the increased use of
collateral.
The Call Report data reflect the significant differences in business strategies among the banks.
The preponderance of trading activities, including both customer transactions and proprietary
positions, is confined to the very largest banks. The banks with the 25 largest derivatives
portfolios hold 95 percent of the contracts for trading purposes, primarily customer service
transactions, while the remaining 5 percent are held for their own risk management needs. The
trading contracts of these banks represent 94 percent of all notional values in the commercial
banking system. Smaller banks tend to limit their use of derivatives to risk management
purposes. [See Table 5.]
The gross positive and gross negative fair values of derivatives portfolios are relatively balanced;
that is, the value of positions in which the bank has a gain is not significantly different from the
value of those positions with a loss. In fact, for derivative contracts held for trading purposes,
the eight largest banks have $356 billion in gross positive fair values and $354 billion in gross
negative fair values. Note that while gross fair value data is more useful than notional amounts
in depicting more meaningful market risk exposure, users must be cautioned that these figures do
not include the results of cash positions in trading portfolios. Similarly, the data are reported on
a legal entity basis and consequently do not reflect the effects of positions in portfolios of
affiliates. [See Table 6.]
End-user positions, or derivatives held for risk management purposes, have aggregate gross
positive fair values of $9.9 billion, while the gross negative fair value of these contracts
aggregated to $8.6 billion. Readers should recognize that these figures are only useful in the
context of a more complete analysis of each bank's asset/liability structure and risk management
process. For example, these figures do not reflect the impact of off-setting positions on the
balance sheet. [See Table 6.]
The notional amount of credit derivatives reported by insured commercial banks increased by 67
percent from fourth quarter levels, or $37 billion, and now total over $91 billion. Notional
amounts for the fourteen commercially insured institutions that sold credit protection (i.e.,
assumed credit risk) to other parties was $46.4 billion, an increase of $32.1 billion from the
fourth quarter of 1997. The notional amount for the eleven commercial banks reporting credit
derivatives that bought credit protection (i.e., hedged credit risk) from other parties was $44.9
billion, a $4.5 billion increase from fourth quarter. [See Tables 1,
3.]
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